Six crew members from two Hong Kong ferries have been arrested after 38 people died in one of the worst maritime disasters in the territory's history.

Hong Kong's chief executive has announced an inquiry into the collision, which took place off Lamma Island, about a mile south-west of Hong Kong. One of the ferries, used by the power company Hong Kong Electric, was taking more than 120 people to watch the fireworks in Victoria Harbour to celebrate China's National Day.

The other ferry, owned by the Hong Kong and Kowloon Ferry (HKKF) company, was returning with passengers from Hong Kong Island.

The collision happened just before 8.30pm local time, when more than 100 people were thrown into the water from the Hong Kong Electric boat. Rescue work continued on Tuesday , with officials warning that passengers could be trapped inside the half-sunken HK Electric ferry. A crane was also brought in to lift the boat out of the water.

After the collision, the HKKF vessel continued into Yung Shue Wan harbour, on Lamma. Some passengers on the HKKF suffered light injuries as they were thrown from their seats.

The HK Electric boat was allowed to carry up to 200 passengers, the company said, denying that it had been too full. According to passengers, the ship went down very fast, within 10 minutes of the collision, giving any passengers trapped inside very little time to escape.

Government departments sent 28 rescue boats and two helicopters quickly to the scene. Thirty passengers were dead at the scene, while a further eight were pronounced dead in hospitals across the territory. Police appealed for more information on the incident.

Hong Kong's secretary for security, Lai Tung-kwok, said at a press conference police had arrested six people. "They are being investigated for endangering people's lives at sea."

The territory's police commissioner, Andy Tsang, said those arrested were involved in the operation of both vessels, and he did not rule out more arrests.

One Hong Kong resident, Tina Tucker, who was staying with friends in Pak Kok on Lamma, described what she could see from the shore as the night's dramatic rescue continued. "I saw the bow sticking out of the water, Titanic style," she said. "The helicopters were circling with big searchlights across the surrounding water, as were a lot of smaller boats with lights.

"There are a number of sampans and junks that have come for a look, but the police have been patrolling and keeping them at a distance."

Chris Head, 48, a Lamma resident of 18 years who was on the HKKF ferry, told the South China Morning Post: "Initially we were trying to put on our life jackets, so we were more concerned with that. But after a few minutes, probably about five, I could see that the end – I couldn't tell whether it was the bow or the stern – of the boat was sticking vertically out of the water."

Hong Kong's transport system is generally efficient, and fatal incidents are rare. Relatives of those who died visited mortuaries and paid their respects to the dead by throwing paper money into the sea.

Hong Kong's chief executive, CY Leung, visited survivors of the incident in hospitals and announced an inquiry.

The Lamma Strait is a busy shipping channel. More ferries than usual were scheduled on Monday, which was a public holiday to celebrate National Day, and was also part of an extended weekend marking the mid-autumn festival.